Is Gaonchips (KOSDAQ:399720) Using Too Much Debt?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Gaonchips Co., Ltd. (KOSDAQ:399720) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Gaonchips

How Much Debt Does Gaonchips Carry?

The image below, which you can click on for greater detail, shows that at June 2024 Gaonchips had debt of ₩4.13b, up from ₩3.81b in one year. But it also has ₩28.7b in cash to offset that, meaning it has ₩24.6b net cash.

How Healthy Is Gaonchips' Balance Sheet?

According to the last reported balance sheet, Gaonchips had liabilities of ₩29.1b due within 12 months, and liabilities of ₩7.25b due beyond 12 months. Offsetting these obligations, it had cash of ₩28.7b as well as receivables valued at ₩16.2b due within 12 months. So it actually has ₩8.54b more liquid assets than total liabilities.

This state of affairs indicates that Gaonchips' balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the ₩519.3b company is struggling for cash, we still think it's worth monitoring its balance sheet. Succinctly put, Gaonchips boasts net cash, so it's fair to say it does not have a heavy debt load!

On the other hand, Gaonchips's EBIT dived 15%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Gaonchips can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Gaonchips has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Gaonchips burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While it is always sensible to investigate a company's debt, in this case Gaonchips has ₩24.6b in net cash and a decent-looking balance sheet. So while Gaonchips does not have a great balance sheet, it's certainly not too bad. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for Gaonchips you should be aware of, and 1 of them can't be ignored.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.